Monthly Market Update – August 2024

Key Points

• SHARP BUT SHORT – August began with a sharp selloff that resulted in the deepest drawdown for the S&P 500 in 2024 and put the tech-heavy Nasdaq in correction territory. However, it was relatively short-lived, and by the middle of the month, most equity indices had recovered and then continued to rally through the end of the month.
  
• BEGINNING OF THE END – Fed Chairman Jerome Powell spent the past two years determined to beat inflation and hiked rates rapidly in 2022 and 2023. The sharp 18-month long hiking cycle was one of the most aggressive policy tightening campaigns in decades. But now Powell is set to reverse course and cut rates on September 18.
• HARD OR SOFT – With the Fed set to begin rate cuts, it’s worth distinguishing between “soft” versus “hard” landings following the start of Fed rate cuts. In a “soft landing,” asset classes like U.S. Large-Cap Equities, International Equities, Commodities, and High Yield Bonds have done well. Not so in “Hard landing” scenarios.
  
• UNDEREMPLOYMENT – While unemployment has remained near historically low levels and ticked down in August, underemployment has accelerated. A broader measure than unemployment, underemployment could be a drag on the economy, and, left unchecked, it could threaten the soft landing scenario.
  
• SOLID EARNINGS – One area that isn’t showing any signs of a hard landing are corporate earnings. Q2-2024 earnings season has proved to be one of the better quarters in the post-COVID era. The S&P 500 reported earnings growth of +11.6% for the second quarter, up from +7.9% pace for the first quarter, and the highest rate since the fourth quarter of 2021.
• FALL SEASON – Like leaves from the trees, stocks tend to drop during the fall months. Historically, September has been the weakest month of the year for stocks. But when separating election years from non-election years seasonal trends diverge. In election years September-October are the two worst months versus August-September for non-election years.

Market Summary

Asset Class Total Returns

Source: Bloomberg, as of August 31, 2024. Performance figures are index total returns: US Bonds (Barclays US Aggregate Bond TR), US High Yield (Barclays US HY 2% Issuer-Capped TR), International Bonds (Barclays Global Aggregate ex USD TR), Large Caps (S&P 500 TR), Small Caps (Russell 2000 TR), Developed Markets (MSCI EAFE NR USD), Emerging Markets (MSCI EM NR USD), Real Estate (FTSE NAREIT All Equity REITS TR).

It’s Déjà vu all over again. In the first week of August, a growth scare from a slowing labor market report and sluggish manufacturing data sent stocks to the S&P 500’s biggest decline of the year. Fast forward to the first week of September, and markets are experiencing a very similar start to the month. After a long weekend in observance of the Labor Day holiday, U.S. stock markets began trading on Tuesday, September 3, with the news that manufacturing Purchasing Managers Indices (PMIs) showed the sector remained in contraction territory for the fifth straight month — and for 21 of the last 22 months. The next morning, the Job Openings and Labor Turnover Survey (JOLTS) was released which also showed a weakening labor market. Job openings ended July far below economists’ expectations hitting their lowest level since January 2021. Then that same afternoon, the Federal Reserve (the Fed) released their latest “Beige Book,” a collection of business anecdotes from the 12 Federal Reserve districts that is published eight times per year, which was the most downbeat in recent memory – particularly with regards to hiring trends. The monthly Employment Situation Report by the Labor Department for August was released on the morning of September 6 and U.S. employers added just 142,000 new jobs, well short of the 165,000 expected. The trend of downward revisions also continued, with June revised downward by 61,000 jobs and July revised downward by 25,000.

But investors are hoping the early September swoon is just a blip like the early August pullback turned out to be. From the August 5th lows, stocks and bonds both rallied to finish August in positive territory. In fact, every major asset class was positive in August, with the exception of small caps stocks, which were down a modest -1.5% after being the top asset class in July. Not a bad showing for a month that got off to such a rocky start. Can investors expect a similar comeback after the early September jitters? That remains to be seen. Historically, September tends to be the weakest month of the year for markets. Since 1928 the S&P 500 has averaged a -1.2% decline in September, and in the last 10 years, it has averaged an average decline of -2.3% – the only month to average a decline. However, this September, markets may have a card up their sleeve. At its September 18 Federal Open Market Committee (FOMC) meeting, the Fed is widely expected to deliver the first rate cut since it began hiking rates in 2022. In addition, virtually every major central bank other than Japan is also cutting their policy rates. A global, synchronized rate cutting cycle should provide a strong tailwind to global equities and bonds and offset some of the recent sluggishness in employment data and economic activity. 

Earnings may also provide a tailwind for markets. The earnings season for the second quarter is effectively complete, and in aggregate, it proved to be one of the better quarters in the post-COVID era. According to data from Bloomberg, the S&P 500 reported earnings growth of +11.6% for 2Q-2024, which was in line with Wall Street estimates. Importantly, the profits were robust across sectors, with nine of the eleven sectors having positive earnings growth. And it’s not just the U.S., economist Ed Yardini points out that foreign stocks earnings just notched a fresh 15-year high.

So sure, seasonal volatility plus a national election may keep investors on their toes this September. But with rate cuts coming from major central banks across the globe and robust corporate earnings being delivered by the world’s companies, it is difficult to be overly bearish.

Source: Bloomberg. Data as of August 31, 2024.
Price Returns for Equity, Total Returns for Bonds.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Quick Takes

SHARP BUT SHORT

August began with a sharp selloff, leading to the deepest drawdown for the S&P 500 in 2024 and putting the tech-heavy Nasdaq in correction territory (a loss of -10 or worse). However, it was relatively short-lived, as the chart below shows. By the middle of August, most equity indices had recovered their losses and then continued to rally throughout the back half of the month. In the end, only the small cap Russell 2000 Index didn’t finish the month with a positive return, but consider that it was the best performing index the prior month with a +10.2% total return. Rate sensitive asset classes like Real Estate and Bonds didn’t see much, if any, drawdown like the equity indexes and finished near their highs for the year as Fed rate cuts draw nearer.

Major Asset Classes Recovered Nicely from an Early August Selloff

Source: Bloomberg.

BEGINNING OF THE END

Fed Chairman Jerome Powell spent the past two years determined to beat inflation even at the risk that it could result in recession. As shown in the chart at the left below, the Fed under Powell raised rates rapidly in 2022 and 2023. The sharp 18-month long hiking cycle is clearly one of the most aggressive policy tightening campaigns in decades. But so far, Powell and the Fed have been able to orchestrate a soft landing in which inflation has been reigned in without a big rise in unemployment or sinking the economy into a recession. If a soft landing is ultimately the outcome, it’ll be a historic achievement and the ultimate redemption after incorrectly predicting three years ago that inflation would be short lived. Powell and Fed policymakers have signaled that they will start cutting rates when they next meet in mid-September. After peaking above 9% in June 2022, inflation has fallen to 2.5% – not far from the Fed’s 2% target. But the unemployment rate has climbed from 3.7% at the beginning of the year. While that’s still a historically low level, evidence is indicating that the buffers that shielded the economy during the hiking cycle, principally pandemic-era savings cushions and an immigration surge that boosted spending, may be fading. With the threat of accelerating unemployment, markets are now pricing in more rate cuts than just a few weeks ago. The chart on the right shows the current market expectations for rate cuts by the end of 2024 will take the Fed Funds Rate down to 4.22% from the current 5.25%. By the end of 2025, market expectations are that rates will drop to 2.94%.

Fed to Begin Rate Cuts

The 2022-2023 Fed rate hiking cycle (left) and market expectations for Fed rate cuts (right, as of 9/3/2024)

Source: The Wall Street Journal, Federal Reserve, Charlie Bilello.

HARD OR SOFT

With the Fed set to begin rate cuts on September 18, it’s worth noting that not all rate cutting cycles are the same. Distinguishing between “soft” versus “hard” landings can paint a different picture on how asset classes may perform following the start of Fed rate cuts. This is particularly true for Equity and Commodity asset classes. A “soft landing” scenario is when the economy slows enough to mitigate inflation without causing a recession. Asset classes like U.S. Large-Cap Equities, International Equities, Commodities, and High Yield Bonds have done well when rate cutting cycles have coincided with a soft landing. “Hard landing” scenarios are when rate cuts coincide with recessions. As expected, riskier assets have suffered much more under this scenario, especially International Equities, followed by the U.S. Value and U.S. Small-Cap stocks. In Fixed Income, quality has shined, as High Yield bonds have seen negative returns while Core Bonds have provided solid returns (helping to diversify portfolios). Longer duration has outperformed shorter duration handily during hard landings. Interestingly, U.S.  Core Bonds have had positive performance and have outperformed Cash by four percentage points on average in hard landings and three percentage points in soft landings. Something to consider as those attractive money market fund and T-bill rates will shrink as the Fed cuts rates.

Asset Class Performance in Hard and Soft Landing Scenarios

Average returns 12 months after the first Fed cut (1984 – Present)

Source: Bloomberg, FactSet, MSCI, Russell, Standard & Poor’s, J.P. Morgan Asset Management.

AFTER THE CUT

For U.S. Equities, what might investors expect at the sector level after rate cuts begin? The table below shows the average performance of U.S. sectors relative to the broad equity market over 12 months following the Fed initiation of rate cuts. The areas in red indicate sectors performing worse than the broader market, while green areas indicate sectors that are performing better. Six months after the Fed initiates rate cuts, pro-cyclical sectors like Consumer Cyclicals and Consumer Services have outperformed the market. Over a 12-month horizon (i.e. 21 trading days) Consumer Cyclicals, Technology, Consumer Non-Cyclicals, and Healthcare sectors become prominent, driven by increased consumer spending, business investment, and attractive dividend yields (relative to lower interest rates). On the contrary, Utilities and Financials typically underperformed the market over the subsequent year. 

U.S. Sector Performance After Fed Rate Cuts

Average sector returns relative to the broad market, Fed first rate cuts (1987-Present)

Source: FactSet, MacroBond.

UNDEREMPLOYMENT UP

Employment might be the key determinant of whether the economy has a soft or hard landing. While the headline “U-3” unemployment rate fell from 4.3% to 4.2% in August, the lesser known “U-6” unemployment rate ticked up from 7.8% to 7.9%. That is the highest it’s been since October 2021 and is up from a record low of 6.5% in December 2022. The U-6 rate is the U-3 rate with the addition of discouraged workers who have stopped looking for work, marginally attached workers who are available for work but have not looked in a few weeks, plus part-time workers who want to work full-time but are working part-time for economic reasons. It is the broadest measure of underemployment, and the accelerating levels this year suggests an increase in underemployment and more discouraged workers. The divergence between the U-3 and U-6 rates has tended to occur like this during early stages of recessions. This may be part of the reason that market expectations for Fed cuts have increased in size lately – that the Fed will need to cut more than previously expected to limit underemployment and preserve the desired soft landing.

Underemployment is on the Rise

The U-6 Unemployment Rate, Percent of the Labor Force

Source: Bureau of Labor Statistics, Trading Economics.

SOLID EARNINGS

One area that isn’t showing any signs of a hard landing are corporate earnings. The earnings season for the second quarter has wrapped up, and in aggregate, it proved to be one of the better quarters in the post-COVID era. According to data from Bloomberg, the S&P 500 reported earnings growth of +11.6% for Q2-2024. That was in line with Wall Street estimates, up from +7.9% pace for the first quarter, and was the highest rate since the fourth quarter of 2021. Importantly, the profits were robust across sectors, with nine of the eleven sectors having positive earnings growth, led by the Utilities, Technology, and Financials sectors. Materials and Industrials were the only sectors with negative results. And it’s not just the U.S., economist Ed Yardini points out that foreign stocks earnings just notched a fresh 15-year high (as measured by the MSCI All Country World ex-U.S. Index).

Year over Year S&P 500 Earnings Growth

Q2-2024 YoY Earnings Growth by Sector

Notes: Volatility surge defined as the Cboe Volatility Index hitting an intraday high of 30 or above. Data between 1992 and 2024.
Source: Cboe, FactSet, The Wall Street Journal.

FALL SEASON

Investors should be aware that leaves aren’t the only things that drop during the fall months. Historically, September has been the weakest month of the year for stocks. But when separating election years from non-election years seasonal trends diverge a bit. In election years, October is the worst month, while non-election years, it is September that is the weakest. With election forces at play, the combination of September-October are the two worst months of the election years versus August-September for non-election years. The lack of clarity about election outcomes, economic policies, and the occasional ‘October surprise’ in the political cycle are likely the causes for the shift in seasonality of election years. Whatever the drivers of seasonality, investors shouldn’t be surprised to see some more choppiness in the markets over the next several weeks. The good news is that regardless of elections occurring or not, November-December tends to be two of the strongest two months of the year.

S&P 500 Index Seasonality

S&P 500 average calendar month return, last 50 years (1974-2023)

Source: Bloomberg, TRPG.

Asset Class Performance

The Importance of Diversification. Diversification mitigates the risk of relying on any single investment. It offers many long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.

Source: Bloomberg.

Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different from the performance of the broad asset classes and to proxy ETFs represented here. US Bonds (iShares Core US Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares US Real Estate ETF). The return displayed as “60/40 Allocation” is a weighted average of the ETF proxies shown as represented by: 30% US Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.

* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.

Chris Bouffard is CIO of The Retirement Planning Group (TRPG), a Registered Investment Adviser. He has oversight of investments for the advisory services offered through TRPG.

Disclaimer: Information provided is for educational purposes only and does not constitute investment, legal or tax advice. All examples are hypothetical and for illustrative purposes only. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed. Please contact TRPG for more complete information based on your personal circumstances and to obtain personal individual investment advice.